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Thinking In Temporal Extremes Can Be Bad For Your Wealth

Bonds, dividend investing, ETF investing, currencies “}); $$(‘#article_top_info .info_content div’)[0].insert({bottom: $(‘mover’)}); } $(‘article_top_info’).addClassName(test_version); } SeekingAlpha.Initializer.onDOMLoad(function(){ setEvents();}); We dance round in a ring and suppose, but the secret sits in the middle and knows. –Robert Frost One of the biggest problems any asset allocator must overcome is the problem of time in a portfolio. I call this the intertemporal conundrum . This describes how our financial lives are extremely dynamic and multi-temporal. That is, they are not one linear time line. Instead, they tend to be a series of short-terms inside of a long-term. This often makes the textbook application of the “long-term” inapplicable with regards to asset allocation. So, as much as we all know it’s silly to think too short-term it’s not totally irrational. After all, being involved in such dynamic financial markets gives us the urge to act and to try to take control of our outcomes in order to reduce uncertainty. We often act because we know there is an inherent short-termism in our financial lives. As I’ve stressed on many occasions , there’s no such thing as a truly “passive” portfolio. But we should be careful not to confuse this with the idea that being too short-term is intelligent. After all, we know that the financial markets tend to be highly unpredictable in the short-term. We also know that the financial markets tend to become more predictable the longer we hold onto assets. This is because the price changes involve too many random variables to be predictable in the short-term. In addition, we know that taxes and fees create potentially insurmountable hurdles so we should implement portfolios that seek to reduce these frictions as best as possible. Generally, our attempts to “take control” of our outcomes in the short-term end up costing us in the long-run. So, we want to think short-term because this gives us comfort and helps mesh with our inherently short-term financial lives. But we also know that thinking too short-term is bad for our wealth because this just churns up taxes and fees inside of highly unpredictable time frames. Then again, we know that we don’t necessarily have a textbook long-term in our financial lives. And we also know that some degree of activity will be necessary at times during the course of our lives so a static “long-term” view doesn’t mesh with inherently dynamic financial markets and financial lives. So, we have quite a temporal conundrum here. Managing this multi-temporal problem is not always easy. The textbook idea of the “long-term” doesn’t fit our financial lives. But we also know that it’s self defeating to be too short-term. So, the key involves finding that happy medium. This is why I like to think of the markets in a cyclical sense. This gives us the ability to construct portfolios that reduce tax and fee inefficiencies, but also take advantage of the fact that our financial lives are dynamic and so are the financial markets. Thinking in extremes is generally bad for your portfolio. And this is particularly important when applying the problem of time to a portfolio. And so, as is generally the case in life, we find comfort living in the extremes without realizing that the middle is often where the secret sits. Share this article with a colleague

Investors – Your Hair Is Not On Fire, You Don’t Have To Get Out Of The Market

Summary The media woods (including Seeking Alpha) are full of dire predictions of market corrections, retrenchment, collapse, from anticipated Fed interest rate hikes, Greek intransigence in the EU, Putin’s Ukranian grab. Oh, woe! It’s all bad. ISIS amok. Massive panicked African emigration to Europe. Police stations and bible study groups becoming shooting ranges. Our own government and AT&T telling lies. Wouldn’t you think folks who help big-$-fund Portfolio Managers realign their holdings would see a market decline coming? But they sure don’t behave like they believe it’s so. What’s the matter with them? Or is it with us? Rational Behavior under threats The normal actions of informed humans sensing impending danger is to erect defenses and plan strategies to deflect or overcome attacks. That is what market-makers [MMs] do in their ordinary course of moving a large part of a trillion dollars of equity investments each day from one set of hands to another. To get balance between buyers and sellers where volume transactions in stocks involve tens and hundreds of $-millions, the MMs usually have to put firm capital at risk temporarily. Hundreds of times a day, every day. They are no strangers to risks and threats. They are highly skilled practitioners of hedging and arbitrage. Those art forms are integral to their enviable successful progress in protecting their capital from harm. So what are they doing to protect against market declines? Nothing out of the ordinary. Just what they have been doing, day-in and day-out. That includes world-wide watching, listening, questioning, reporting, recording, evaluating, communicating. It’s strange that organizations so well resourced and disciplined would miss the threats that so many others claim to be about to harm all of us. Yet MMs continue to behave in the same manner, hedge to the same degree, pay for protection about the same amounts, in deals structured the same way as they have been, over many past months. We have been watching their behavior for decades They clearly behave quite rationally, rather systematically, given what they know at various times. In our recent SA article of “Worry, worry, worry” we demonstrated the differences present as they sense impending problems or ongoing good times. Our behavioral analysis of their hedging practices daily has not changed over decades. It shows the asymmetry of their price change expectations for 3,000 or more stocks day after day. For each stock we produce what they must think their serious, powerful clients are likely to do to the prices of stocks the clients want to own in the future, and to ones they no longer want to own. And to the price points where the clients might change their minds. The ranges of possible price prospects get described by a single simple measure, the Range Index. Its job is to tell the balance between upside price change potentials and downside price change exposures. Each stock, ETF, or equity market index has a Range Index [RI] whose number tells what percentage proportion of that subject’s likely coming price range lies below its current market quote. A low RI suggests limited downside, ample upside. So the RI becomes a common denominator for price expectations, a very useful yardstick to compare the expectations of many varied issues. And, in the aggregate, to have a sense of what the market outlook overall might be. That’s what is shown at various stages of market price change anticipations in the “Worry, worry, worry” article. Figure 1 updates that distribution of informed professional expectations to last night. Figure 1 (click to enlarge) (used with permission) The average Range Index of the 2,500+ names covered in this picture is 28, meaning that the typical stock has better than twice as much upside as downside. A 50 RI would make the odds of up vs. down a coin-flip. How many in Figure 1 have that kind of prospect, or worse (a higher RI than 50)? A negative RI means that the subject’s current price is lower than the bottom of the price range regarded as likely or justifiable. That condition sounds like “cheap” to many Graham & Dodd folks. Figure 2 tells what has happened to stock, ETF, and market index prices in the 16 weeks following the daily observation of Range Indexes for this population during the past 4-5 years. Some 2,959,450 observations built this display. Figure 2 (click to enlarge) That 1 : 1 blue row of Figure 2 is the overall population average, positioned at the 50 RI level. That’s where up and down price change prospects are held equally likely. The green rows above are of progressively lower Range Index (or cheaper) forecasts, and the red rows below the blue row are of progressively more expensive RIs. The maroon-count row just above the blue row is coincident with today’s population average. But we should be more interested in what can be done to improve an existing investment portfolio than in speculating about what might happen to the market as a whole. Play the game better What is of interest to active investment managers is the potential payoffs and odds for success in buys of those stock or ETF RI forecasts up in the top rows of the table. And what might best be purged from a portfolio where the holding’s RI is among those below the 50 blue-row level – higher RIs than 50. For perspective, take a look back at Figure 1. Today, just as in most daily experiences, there are many promising prospects for purchase off to the left in the Figure 1 distribution. To the extent that these have proven to be reliable, credible forecasts, then it is likely that what happens to the market as a whole has little impact on their near-term future. And it is their near-term future that active investors should be concerned with. In today’s global, high-tech, communicative and competitive networks of business activity, reaching out with forecasts as much as a year or more is not investing, it is just speculating. While overall-market forecasters are speculating as to where the averages will be a year or more from now, active investors will have the opportunity to have capitalized on interim opportunities, compounding their triumphs (often 3-4 times in a year) net of their mistakes (typically 1 in 2 years) to produce rates of gain that may be multiples of what the market averages may have produced in capital gains. Those kinds of odds, 6 out of 8, or 7 out of 8 wins in two years for each allocation of capital, are quite doable when good guidance is provided. Usually the rates of gain in the wins are well above those of the market, and the effect of compounding can multiply the progress in wealth-building well beyond the (now highly competitive and economical) transaction costs or infrequent loss. As an example, using market-maker forecasts to compare over 2,500 equities daily, and ranking them based on how well prior forecasts similar to the current-day forecast have performed, over 1900 opportunities have been identified so far in this 2015 year at a rate of 20 a day. Following a time-efficient discipline standard of portfolio management to all, of the closed out positions (more than half) the average annualized rate of net gains are +31%, compared to that of SPY at +5.1%. Conclusion There are nearly always attractive stocks or ETFs to buy, regardless of overall market prospect appearances. The diversity of opportunities among over 3,000 potential quality portfolio investment candidates provides a rich field of perpetually price-renewed prospects. But investors need to have a portfolio management strategy and discipline urging them to be frequently aware of developing opportunities and maturing prior actions in need of reinvesting. This is called active investing, and will involve more attention and time commitment than many investors are willing or need (the most fortunately capitalized) to make. The rewards for active investing are demonstrably far better than most investors of all types have been led to believe. Those investors faced with impending capital-requirements having fixed time deadlines may find that the only way now that will satisfy their needs makes adoption of active investing a most sensible practice. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The Fed Provided A Short-Term Boost To SLV

Summary The FOMC meeting concluded with a dovish statement and press conference. The silver market benefits from a dovish Federal Reserve. A potential rate hike could have a modest, negative impact on the price of SLV. The FOMC, as expected, didn’t raise rates and presented a dovish statement without dissenters. This news provided some backwind to the iShares Silver Trust ETF (NYSEARCA: SLV ) that came up in the last few days, albeit it’s still down by 8.5% over the past month. Let’s examine the recent FOMC meeting and its possible implications on SLV. Following the recent FOMC statement and press conference, the market revised down its outlook of the Fed’s rate “lift off”: The implied probabilities dropped to a 17% chance of a rate hike in September and 57% in December. In January 2016, the odds are 72% – nearly the same odds for a December rate hike only a week ago. The statement, which wasn’t changed much and didn’t offer any major headlines, still led to a modest rally in the price of SLV, as presented below. The dovish tone in the statement and Yellen’s press conference that followed suggested that even after the inaugural “lift off”, the FOMC will keep rates low – conditions that benefit the silver market. (click to enlarge) Source of data taken from FOMC and Google Finance The FOMC revised down its projections for the 2015 U.S. GDP growth rate from 2.5% in March to 1.9%. The rate of unemployment slightly increased to 5.25%. There weren’t any other major changes in the FOMC’s economic projections. Since Yellen reiterated that the first rate hike will still be data dependent, this means that if in the next few months the economic data show a stable recovery, e.g. NFP reports keep showing steady growth in jobs, lower unemployment, faster growth in wages, better GDP figures, higher inflation (just to name a few), the FOMC could decide to raise rates this year. As long as the FOMC keeps rates low, the silver market in general and SLV in particular benefit from it. Also, even if the FOMC were to start raising rates, the cash rate is likely to remain low, as Yellen suggested in the press conference, for a while. After all she tried, yet again, to diverge the attention from the historic first rate raise to the pace of subsequent rate hikes. She emphasized that rates will rise gradually; as such, this means the normalization policy is likely to have a modest adverse impact on SLV. In terms of the dot plots, FOMC members are still incline to raise rates this year, perhaps by September – this will allow for at least two rate hikes of 0.25% and bring the cash rate to 0.5% by the end of the year. For 2015, the median target range of the Federal Reserve hasn’t changed – it’s at 0.625% – albeit fewer FOMC members have picked higher rates and the projections are now more concentrated around lower interest rates, as you can see below: Source: FOMC’s website For 2016 and 2017, members slightly lowered their projections so that the median point declined by 0.25 percentage points for each year. This is another dovish indication that the trajectory of the future rate hikes could be more moderate than previously projected. Source: FOMC’s website In a CNBC interview, Richard Fisher, who is considered a hawk and was former president of the Federal Reserve Bank of Dallas and FOMC voting member, stated the dot plot outlook for the coming years is less relevant since the current members may not be there to make rate decisions in 2016-2017. This may be right, but since Yellen will remain at the Fed, we are still likely to see additional dovish FOMC decisions in the coming years. The market’s reaction to the dovish statement also included a depreciation of the U.S. dollar against leading currencies, which also contributed to the modest rise in shares of SLV. Nonetheless, the U.S. dollar could start to rise again especially against the euro – the ECB’s QE program and the ongoing Greek debt crisis are likely to drag down the currency – and yen. A stronger U.S. dollar could play against the price of SLV. The silver market isn’t out of the woods, but the FOMC provided a short-term boost to SLV. The market doesn’t seem convinced that the Fed will raise rates this year. As such, if and once it will occur, it could result in a modest drop in SLV prices. Until such time, as long as the FOMC produces dovish statements, silver will benefit over the short run. For more see: Will Higher Physical Demand for Silver Drive Up SLV? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.